What Really Happened to Income Inequality in the 20th Century?

Guest post by Scott Winship, Brookings Institution. Follow him on Twitter: @swinshi

I promised that this was the last post I would write this week dwelling on rising inequality at the top, and I do want to shift to the comparatively under-appreciated lack of rising inequality in the bottom half of incomes.  But bear with me, as this turned into two separate posts. 

To review, in my first post on high-end inequality, I showed how outsized gains at the top are mostly concentrated in the top half of the top one percent and noted that these gains came even as the poor and middle class became significantly better off.  In my last post, I demonstrated that some potential shortcomings of these estimates do not seem to actually alter conclusions about the rise in inequality.  In my next two posts, however, I want to nevertheless flag some important sources of ambiguity about the data on top incomes that are available.

First, there is some question as to how robust some of the key results for early decades in the Piketty/Saez series are. You can use the figures they have made available to compute the average income of the bottom 90 percent or 99 percent of tax returns over time. In the chart below, the red line gives the trend in the bottom 90 percent's average income, pegged to 1917 levels.  It shows an implausible 91 percent increase over the three-year period from 1940 to 1943.  As the chart indicates, a lot happened during these years that might affect the Piketty/Saez estimates.  From 1939 to 1946, federal income taxes went from being something only the rich paid to something nearly everyone paid.  This fact matters because the low filing rates in the first part of the decade force Piketty and Saez to compute their figures differently than they do in later years.  Until 1944, Piketty and Saez determine the share of income received by the top ten percent (or top one percent) of tax returns by comparing the income they report to an aggregate figure drawn from national statistics collected outside the IRS.  They are forced to do so rather than compute total income received from the tax return data itself, which isn't informative in years when few people filed.

The purple line in my chart attempts to correct the average income estimate for the bottom 90 percent.  Let me get into the weeds in a moment to say what exactly I did, but first note what happens to the share of income received by the top ten percent when I make this correction, conveyed by comparing the blue and green lines.  Rather than showing pre-1940 income concentration at the top to rival that in the last 30 years, and rather than showing a big decline in income concentration in the early 1940s, the revised trend indicates hardly any change in income concentration from 1930 to 1980.  Since the basic assumption among researchers who study income inequality trends is that inequality has followed a big U-shaped trend over the past 100 years, this is kind of a big deal (but of course, it makes the recent run-up in inequality that much more striking).

ALL ABOUT THE LAST 30 YEARS

Now, before anyone runs too much with this revisionist take, I don't want to make the strong claim that inequality didn't change much until the past 30 years. For starters, if you do this same exercise for the top one percent rather than the top ten percent, you still get a big decline in inequality between 1930 and the mid-1970s, though smaller than before.  The 1929 peak drops from 24 percent to 19 percent, and the early 1940s decline that Piketty and Saez show shrinks dramatically. It would certainly require a change in thinking about historical income patterns if half the drop in the share received by the top one percent from 1928 to the mid-1970s accrued to the next richest 9 percent.  In the Piketty/Saez data, that next-richest 9 percent didn't receive any of the bounty.

More importantly, however, other data sets using other measures of income and earnings inequality also show big declines in the 1940s (though note that the trend for the top one percent doesn't have to mirror what happens to inequality among the 99 percent).  The basic point is just that relatively innocuous-seeming decisions can produce pretty dramatically different numbers in this earlier period. 

Furthermore, marginal tax rates rose dramatically over the period.  In 1929, a taxpayer with $100,000 in today's dollars paid a 3 percent marginal tax rate, and it was just 10 percent in 1940.  In 1941, however, it jumped to 21 percent, rising to 30 percent in 1942 and to 38 percent by 1948.  For a taxpayer with a million dollars in income in today's dollars, the rise was from 23 percent in 1929 to 39 percent in 1939, jumping to 51 percent in 1940, 63 percent in 1941, 78 percent in 1942, and 89 percent by 1948.  You think these taxpayers had strong incentives to keep their incomes off of federal income tax returns (and out of the Piketty/Saez data)?  Not only were the incentives strong (and options for avoidance plentiful), but the IRS was less equipped to keep up with tax avoidance practices in the days when the federal government was much smaller than it was today.

What about the high-end income concentration estimates for the past thirty years? Anything left to worry about there?  You'll just have to read the next post to find out.  In the meantime, here are the deets for the "correction" I made above.

From 1943 onward, I use the Piketty/Saez numbers (though they show up in my chart below the red line because they are now pegged to a higher 1917 estimate).  From 1940 to 1943, I rely on the annual percent change in average earnings (not total income) for all workers (not just the bottom 90 percent of tax returns) from a separate data source.  Specifically, Saez has a paper with two other coauthors using Social Security Administration data on earnings, and to his credit, they make lots of their figures publicly available too.  In general, the annual growth in SSA average earnings tracks the annual growth in the Piketty/Saez bottom-90-percent income very well over the decades for which both data sets provide estimates--except from 1940-41 to 1946-47. 

After making this correction, from 1917 to 1940 I go back to the annual growth rates in the Piketty/Saez data (the SSA data only goes back to 1937).  In other words, I go backward from 1943 to 1917, correcting the 1940-43 trend, which raises the pre-1940 average incomes when I go backward from 1940 to 1917. You can see that this fixes the big 1940-43 increase that the red line shows. The big assumption here is that the top 10 percent incomes are measured well prior to 1943 (or at least as well as they are after 1943) but the bottom 90 percent incomes are not (because they are residuals from the separate aggregate national income data used).

This article available online at:

http://www.theatlantic.com/business/archive/2012/05/what-really-happened-to-income-inequality-in-the-20th-century/257156/